Canada Dutch Disease? OECD Says Yes

CP
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By Julian Beltrame, The Canadian Press

Posted:
06/13/2012 10:00 am EDT
Updated:
08/13/2012 5:12 am EDT

A Suncor oilsands mine facility seen from the air near Fort McMurray, Alta., Monday, Sept. 19, 2011. The OECD is weighing in on the controversy surrounding whether Canada is suffering from an economic condition known as Dutch Disease, and its qualified answer is yes. (THE CANADIAN PRESS/Jeff McIntosh) | CP

Resource-rich provinces such as Alberta, Saskatchewan and Newfoundland have prospered, while others have fallen behind, in part because a commodity boom has strengthened the Canadian dollar.

A similar problem occurred in the Netherlands after its North Sea oil fields created a new source of resource wealth, hence the term Dutch Disease.

"I don't think you can really deny it," said Peter Jarrett, one of the report's author, in an interview.

"You can't explain the entire pattern of the history of manufacturing just by exchange rates, that goes too far, but anyone who argues it has no effect is clearly not looking at the data.

The 128-page report from the multinational organization does not use the term Dutch Disease, but it traces the steep decline of manufacturing in Canada since the turn of the century and the equally sharp climb of the loonie. During the same period, demand and prices for Canadian commodities, particularly oil, also accelerated to record levels.

"The export-oriented manufacturing sector had by 2011 shrunk sharply to only 12.6 per cent of total value added, down from a peak of 18.6 per cent in 2000. Its share of employment has also fallen substantially over the past decade from 15.2 per cent to 10.2 per cent, and somewhat more than in the United States," it notes.

"Both outcomes have been clearly correlated with exchange-rate developments."

Meanwhile, it adds: "Alberta remains the most affluent province, thanks to its energy wealth."

The fact that Canadian manufacturing has fallen further and faster than the United States, where resources play a smaller role in the economy, can be partly explained due to exchange rate movements, Jarrett said.

The analysis mirrors that of NDP Leader Thomas Mulcair, who has been accused of pitting regions against each other for political purposes.

Other reports on Dutch Disease in Canada have tended to reach incompatible conclusions.

Last month, the Pembina Institute said what it called "oilsands fever" spread benefits unevenly across the country and could be hiding economic turmoil down the road.

A second report from the Macdonald-Laurier Institute argued that all provinces benefit from the commodity boom. And yet another, from the Institute for Research on Public Policy, split the difference — it found some evidence for the phenomenon, but said the impact was smaller than feared.

The OECD report says there's no question the decline in central Canada's manufacturing base is correlated to the appreciation in the dollar.

Economists from the organization were to hold a press conference Wednesday morning in Ottawa on their findings.

The report does not call for a for a slowing down of resource development, particularly in Alberta's oilsands, although it continues to push for a carbon tax.

Instead, it advocates that Canada boost innovation and invest in churning out skilled workers. That will lead to higher productivity, which should benefit the non-resource sectors.

The report touches on a wide range of economic issues impacting Canada, including interest rates, debt, government fiscal health and immigration.

It gives the most space, however, to why Canada is unable to capitalize on its highly-educated human capital to commercialize ideas and innovate.

The country's productivity has actually fallen since 2002, the OECD notes with alarm, while in the U.S. it has increased by 30 per cent over the past two decades.

This is apparently not a unique Canadian problem. Other resource-rich countries, like New Zealand and Norway also underperform when it comes to innovation, the report states.

Many of the solutions for the innovation deficiency advocated by the OECD have been advanced before, including that businesses spend more on research and development, and that governments devote resources to post-secondary schools that turn out highly-skilled workers.

But the report takes issue with some of changes to R&D funding proposed by Finance Minister Jim Flaherty in his March 29 budget. The report says Flaherty should have followed more closely the Jenkins report recommendations he commissioned by narrowing the tax credit gap between small and big companies, rather than increasing it, and by not being afraid to "pick winners" as long as firms also contribute to their own research.

On the current state of the economy, the OECD says Canada has weathered the global crisis comparatively well and should grow by about 2.2 per cent this year and 2.6 per cent in 2013.

But, as it has noted before, Canada faces a potential future risk over the high levels of household debt and real estate prices.

"Low interest rates are for now keeping mortgage and debt-servicing affordable for most, but the share of indebted households spending more than 40 per cent of their income on interest payments remains about the 2000-2010 average," it warns.

In 1977, The Economist coined the term "Dutch Disease" to describe the phenomenon of economies whose industrial bases suffer when large deposits of energy, such as oil or natural gas, are found.
The magazine named it "Dutch Disease" because of the rapid deindustrialization seen in the Netherlands in the years after a major offshore natural gas find in 1959.

One of the effects of becoming an energy-exporting country is that speculators will start treating that country's currency as a "petro-dollar." The value of the currency rises (and sometimes falls) with the cost of the country's energy exports, which often means it becomes too high in value for exporters in other sectors. Those exporters then see their sales decline, and manufacturing suffers as a result.

As the energy export sector grows, it attracts workers from other sectors, including manufacturing, leaving fewer skilled people to fill jobs in those areas. This is known as "direct deindustrialization."

As money flows to the energy exporters from energy consumers around the world, it increases the amount of spending cash people have. That additional cash increases the demand for non-manufacturing labour -- things such as beauty salons, travel, entertainment -- which in turn sends people into those jobs, and away from manufacturing. This is known as "indirect deindustrialization," or "the spending effect."

Economists are in disagreement about whether Dutch Disease is real, whether it's an important phenomenon, and whether it actually happened in any given economy. Fifty years after the Netherlands' big natural gas find, there is no consensus on whether the country experienced the disease named after it, with many economists arguing excessive social spending was behind manufacturing's decline.

In Canada, Dutch Disease has become a highly polarized political issue. When NDP Leader Thomas Mulcair and Ontario Premier Dalton McGuinty recently referred to what they see as the problem of manufacturing suffering under the weight of a booming oil industry, it prompted accusation of divisiveness from leaders of Western provinces.
Economists don't agree either. While a recent study from the Pembina institute argues the phenomenon is real and having a negative impact, others argue the strength of Canada's oil sector is creating internal demand that's offsetting the loss of manufacturing exports. Yet others say Dutch Disease is only a part of the problem, and that other factors -- like offshoring of jobs to developing countries and increases in productivity -- are also to blame for manufacturing's decline.